The banks are at a record high. Safe income stocks are flying. What is going on and can it continue? This is the question for almost every long-term investor/retiree, can you still buy or are you buying at the top. It is the debate du jour.
Let's give one side of the argument, the argument for the safe income stocks continuing to rally for years to come, the glass half-full argument, at the risk of getting you all in at the top. There are a number of drivers for the safe income stocks and you have to decide if they will last. They include:
■Low interest rates. These are core to the interest in safe equities as bonds and term-deposit returns fail to deliver on the income expectations of super funds and, in particular, retirees. You can't live off bonds. The safe equities rally relies on global interest rates staying at record lows. Will they? You choose.
■ Growth in the super industry. The government forecasts super assets to rise from $1.5 trillion to $7 trillion by 2030. In other words super assets will grow by 470 per cent in 17 years, 12.5 per cent compound a year and they will buy equities. Is that true?
■Baby boomers moving into pension phase. The first baby boomer is now 67. There are 5.5 million of them in Australia - 39 per cent are over 60 with another 61 per cent (about 3.35 million) yet to hit retirement age. This really is the huge driver for "safe equities", millions of people moving into retirement whose focus goes from accumulation (looking for capital gains) to preserving capital and earning a return on it in order to live.
That transformation in focus is driving money from growth and risk to safe income stocks. The growth in retirees is key to safe income stocks and this one is certain, it is happening.
■Growth in SMSF usage. The number of SMSFs grew 8 per cent last year. This is still a transition and it matters because as funds move from managed funds to SMSFs the nature of where the money is invested changes to focus more on domestic equities and cash rather than international equities and no cash.
■Risk aversion. As the number of retirees in pension phase grows, the risk appetite of the average investor falls and as it does the priority moves to preserving capital, not risking it. As it does, everyone learns that it will not be enough to simply focus on dividends and the size of the yield (the yield trap) but will be a lot smarter than that, because they know that a big dividend doesn't mean a safe stock - it can mean the opposite. What they are now looking for is safety before income, which means the focus goes to high-quality stocks rather than high-income stocks.
In other words it's no good BHP, Rio and Woodside Petroleum becoming income stocks unless they can afford to. Although all three stocks currently have returns on equity of 15 per cent to 30 per cent retiree investors are going to steer clear of them if those returns on equity are falling (which they are). Its about risk first, not yield.
■Stocks like bonds. What retirees really want are bonds with a high return, but they don't exist, so what they are buying are equities that look like bonds. In other words stocks that provide reliable, safe earnings streams from which they pay reliable, sustainable, safe, affordable dividends that return more than bonds. No wonder hybrids walk off the shelf, they look low risk and offer a higher return.
If bonds are priced according to their credit ratings then this is exactly how equities will be valued/differentiated from now on, on risk. Low risk equals higher P/Es. You should also note on this basis that volatile, risky equities with unreliable earnings streams (resources) are going to be discounted (they already have been).
I can't help feeling the above arguments are being used to justify past performance rather than predict future performance. It would be typical of 99 per cent of sharemarket commentary.
But it does provide the elements for an interesting debate and explains why it might still be OK to buy at the top, because we are possibly still in the very early stages of this safe equity appetite and it could run for years. Either that or we'll be looking back at this article and saying, "When Marcus wrote about it, that was the top!"